The Inefficiency of China’s ‘A Shares’ in a Chart

By Brendan Conway

Let’s conjure an imaginary stock listing in Toronto for Apple (AAPL) or Tesla (TSLA). We’ll call them “T shares.” How will this other share class trade?

Probably very closely to what’s happening to the U.S.-listed stock. That’s because anything else would be ripe for arbitrageurs. The two share classes offer a piece of the same company. Both markets are modern, reliable, and heavily populated by traders. So prices should converge.

Things work differently in China’s tightly restricted A-share market. Here, a company’s stock often trades to wide premiums versus the very same company’s Hong Kong-listed shares. One piece of this puzzle: Foreigners make up only 1.5% of A-share stockholders. There are fewer opportunistic traders ready to pounce when prices get out of whack.

There’s an index to track the A-share premium, the Hang Seng China AH Premium Index, which measures the average price difference of the largest and most liquid companies’ “A shares” versus the same companies’ H shares, meaning stocks traded in Hong Kong.

Notice how the A shares reached a 40% premium in September 2011, and got as high as 75% or so above Hong Kong during the worst of the financial crisis. (Lately, the premium is compressed.)

It will be interesting to see whether things stay near parity now that this controlled market is cracking open to foreign investors. Either way, the trading history is just one indication that this is an inefficient market — one whose opening must look attractive to risk-takers and arbitrageurs. But it’s not a place where the risk-averse need immediately invest.

Chris Konstantinos, a director at ETF manager RiverFront Investment Group, is among those who won’t make an immediate leap. “Our plan is to take a very cautious, wait-and-see attitude,” he told me for last weekend’s Barron’sETF Focus column. “We want to see how the A shares trade under increased scrutiny.”

About Focus on Funds

As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.

Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.